Ninja Simulations – FAR 31

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    jberrier
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    NINJA Question –

    TBS 31 for FAR asks to calculate basic EPS and diluted EPS. I had no problems for the basic EPS calculation, but I don’t understand why the correct answer for the diluted calculation is subtracting preferred dividends from net income in the numerator. This makes sense for the calculation of basic eps, but if the cumulative preferred stock were converted, then one shouldn’t have to subtract or add this to net income–at least that’s what I think. By leaving net income at $46,575 and dividing by 22,500 shares (21,500 + 1,000), I get diluted eps at 2.07, meaning that that the preferred stock is anti-dilutive and diluted eps should equal basic eps of 2.05. Can someone explain if my reasoning is wrong, or if the answer is incorrect?

    I will post the question below. Thanks!!

    –At the end of 20X1, the following information applies to Brady Company:

    Net income: $46,575

    Common stock issued: $215,000 ($10 par value)

    5%, $50 cumulative preferred stock issued: $50,000

    Dividends declared on common stock: $21,500

    Convertible, noncumulative preferred stock issued at $50 par: $50,000

    Use this information to compute the basic and diluted earnings per share (EPS) below. Assume that the common shares given are presented as a weighted average.

    Compute the basic EPS for Brady Company:

    Explanation Given:

    Diluted EPS:

    Diluted EPS = Net income – Dividends on preferred stock /

    Weighted average common shares + Potential common shares

    The dilution results from the assumption that convertible securities were converted, that options or warrants were exercised, or that other shares were issued on the satisfaction of certain conditions.

    In this problem, Brady Company has issued convertible preferred stock at $50 par ($50,000 ÷ $50 = 1,000 shares issued). These stockholders have the ability to convert to common stock.

    This preferred stock is noncumulative, and no preferred dividends have been declared, so we do not have to take these dividends into account in the calculation.

    Diluted EPS = $46,575 – $2,500 /

    21,500 + 1,000 = $1.96 per share

    (The references for this question are sections 2335.12-.13 in the Financial Accounting and Reporting Reference Volume.)

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